A person who has a contractual right to attend board meetings as an observer generally isn’t considered to be a director for purposes of Section 16, at least not by the observer or the issuer. The determination is usually based on whether the observer “functions” as a director, and the observer’s inability to vote on board resolutions, or in some cases even participate in discussions, usually drives the conclusion. A Third Circuit case decided yesterday supports that outcome, although a dissenting opinion suggests that companies should still undertake a careful analysis of the individual’s role.
The case, Obasi Investments Ltd. v. Tibet Pharmaceuticals, Inc, involved a claim by defrauded investors in an IPO that two board observers, who were identified as such in the IPO prospectus, were liable for the fraudulent prospectus under Section 11 of the 1933 Act, which permits an action against any person named in the registration statement as a director or “person performing similar functions.” The district court had declined the observers’ motion for summary judgment, holding that whether they were directors for purposes of Section 11 required further development of the facts. The Third Circuit reversed, holding that the observers were not directors “as a matter of law.” The Third Circuit relied most heavily on the fact that the observers couldn’t vote, but also noted that they were aligned with a placement agent who had secured the board observations right, not with the company or its shareholders, and that the observers’ tenure was set by contract, not a shareholder vote. The court said its conclusion was consistent with the definition of “director” in Rule 405 of Regulation C, which happens to be the same as the definition of “director” in the 1934 Act, so the decision is good news for board observers who don’t consider themselves to be directors for purposes of Section 16. The dissenting opinion, though, expressly refers to SEC releases stating that, for purposes of Section 16, a person’s title alone is not determinative of whether that person is a director, and instead the focus should be on whether the person performs, in the judge’s words, “duties likely to make him privy to inside information.”
The 2 to 1 decision shows how close the call may be in individual cases. So, while the case doesn’t call into question companies’ usual treatment of board observers (or honorary, advisory or emeritus directors) under Section 16, it is a reminder that every determination needs to be based on an analysis of the particular facts.
-Alan Dye, Section16.net July 24, 2019
